• Even without getting into any quantitative measure of vulnerability, it is quite clear that the rupee is under pressure.
  • In the last one year, it depreciated by over 10%, has crossed the psychological marker of ₹80 to a dollar, and India’s foreign exchange reserves are down by more than $100 billion.

The rupee is falling on account of two factors.

  1. The first is the widening current account deficit, mainly owing to the rise in the price of oil triggered by the Ukraine war.
  2. And the second is capital outflows, driven by a strengthening dollar on the back of aggressive rate hikes by the U.S. Federal Reserve.
  • For one, there was pressure built up in the exchange rate then whereas the exchange rate today is tracking fundamentals more closely.
  • Second, India’s macro situation then was fragile because of year-on-year high fiscal and current account deficits.
  • Most importantly, India’s current war chest of reserves inspires confidence that India lacked at that time.
  • Arguably, the pressure on the rupee has softened, if only modestly, compared to six months ago, because the price of oil which was ruling above $100 to a barrel has since dropped to $88, India’s monthly trade deficit appears to have come off the peak, and capital flows are stabilising.
  • This is by no means to suggest that India is slowly heading into a comfort zone. On the contrary, the country remains vulnerable on many counts.
  • By far the most important vulnerability stems from the current account deficit (CAD) — a broader measure than the trade deficit because it takes into account invisibles such as, for example,
  • Travel and tourism — is expected to widen to beyond 3% of GDP this year, higher than 2.5% that the RBI considers to be the safe limit.
  • India can withstand a one-off overshoot of the CAD beyond the safety zone, but there can be no reassurance that it will soften soon given the Fed’s seeming commitment to continue hiking rates until inflation in the U.S. is tamed and there is the unlikely prospect of the Ukraine war ending anytime soon.

India’s vulnerability is the fiscal deficit.

  • For all the talk of fiscal consolidation, the combined fiscal deficit of the Centre and the States is still above 10% of GDP, possibly higher if the contingent liabilities, especially of the States, are also brought to the book.
  • It is worth remembering that India’s severe balance of payments crisis in 1991 and the near crisis in 2013 were both consequences of fiscal deficits spilling over into the external sector. The twin deficit problem is still very much with us.
  • Some comfort is seen to be drawn from the fact that this is a global problem, and India is not in it alone; also, that the rupee has fallen much less than most currencies, including hard currencies such as the euro and the pound.
  • That comfort is misplaced. Even if the problem is global, the consequences are domestic. Moreover, India’s fiscal situation is more stretched than that of most economies.
  • Quite justifiably, India has come to look upon its foreign exchange reserves as a buffer against exchange rate pressures.
  • It cannot get too sanguine though. There are many metrics for measuring the adequacy of reserves; one of them is to see them as a ratio of GDP.
  • That ratio which stood at 21% in March 2022 as a proportion of FY22 GDP has since declined to about 17% of expected FY23 GDP, not very much higher than the ratio of below the 15% it had dipped to during the taper tantrums of 2013.
  • Besides, experience shows that in times of pressure, market perceptions are shaped more by how rapidly the reserves are falling — the ‘burn rate’ — rather than the absolute level of reserves.

Way forward

  • For sure, a weaker rupee will be inflationary, but the RBI should deal with that with its monetary policy as it already is doing.
  • We live in a difficult world where macroeconomic management is hostage to global economic conditions.


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